The Treasury is an institution with a sense of history. Officials, as a matter of course, have a deep knowledge and understanding of economic crises of the past. The “pound in your pocket” devaluation of November 1967, the expansionary “Barber boom” initiated by the budget of March 1972, the IMF bailout of September 1976 and our ejection from the ERM in September 1992 will be all too familiar as case studies of failure from which lessons should be learned. To add to that list – perhaps the worst of the lot – will be Kwasi Kwarteng’s economic statement of 23 September 2022.
Culpability, of course, lies with ministers. A chancellor of the exchequer should have a feel for what the market will tolerate and the sense not to push their luck. Nonetheless, it would be no surprise if there is some soul-searching among senior officials as to whether more could have been done to warn the politicians that £45bn of unfunded tax cuts would break the markets’ patience. It did not help, of course, that their boss – Permanent Secretary Tom Scholar – had just been sacked for being insufficiently positive.
A willingness to tell truth to power is always necessary but it is particularly essential at the moment. We are not through this crisis yet. The currency and gilt markets remain jittery and, with the Conservative party conference commencing in Birmingham , every word said by the prime minister and chancellor will be closely scrutinised to see if they fully comprehend the situation. The evidence so far is not encouraging.
For much of the past week, ministers have attempted to deny that the market turbulence was the direct result of Kwarteng’s statement. They have also blamed the markets for failing to appreciate what they believe will be the truly awesome impacts of their growth policies. As for addressing the new hole in the public finances that has been created, the government’s answer is simply to cut spending. Departments will have to “trim the fat” and reduce the welfare budget.
The Treasury is going to have to inject some realism into ministers’ thinking.
Denying the obvious – that the turmoil stems from Kwarteng’s statement – will only unsettle the markets. The first step on the road to recovery is to recognise the problem.
There are some good proposals in the government’s growth plan but none of them will be immediately transformative, and the most economically positive – increasing immigration and liberalising planning law – are so controversial that they might not happen. In any event, the higher interest rates that have resulted from recent market turmoil will weaken economic growth in the next couple of years. Assuming that the markets have underestimated the government’s supply-side policies would be foolish.
As for thinking that the public finances can be put on a sustainable footing solely by taking an axe to public spending, a moment’s thought about the implications reveals that this is not credible. Reducing benefits during a cost of living crisis while cutting taxes on those with the highest incomes; reducing expenditure on the NHS during a winter that is likely to be particularly tough; substantially reducing real-terms public sector pay at a time of full employment: none of these policies is sustainable.
The immediate task for Treasury officials is to disabuse ministers of their delusions. They will have assistance – the Office for Budget Responsibility will tell some economic home truths, Conservative MPs are already setting out the political realities – but they may not have long. While ministers refuse to face up to reality, the risk of a further crisis in market confidence remains.